How Much Debt Is Too Much? (At what point does it become unsustainable?)

The latest budget projections show the national debt rising from $5.8 trillion last year to $7.6 trillion this year and $14.3 trillion in 2019. According to the Congressional Budget Office (CBO), the debt will rise from 40.8% of the gross domestic product in 2008 to 53.8% in 2009 and 67.8% in 2019.

This raises the question of how much debt is too much. At what point are the economic consequences in terms of inflation, higher interest rates, slow growth or a collapsing dollar so severe that everyone recognizes that radical action is required?

This is a surprisingly difficult question to answer. The only time in American history that the debt has been as large as projected was during World War II and the decade following it. The Civil War caused the debt to rise from 1.4% of GDP in 1860 to 31% of GDP in 1867. During World War I, the debt rose from less than 3% of GDP in 1915 to about a third of GDP in 1919. On the eve of World War II, the debt was a little more than 50% of GDP, rising to 122% of GDP by 1946.

The rise in debt undoubtedly contributed to inflation during the wars. The price level increased by about 25% per year during the Civil War and about 20% per year during World War I. Despite the larger debt, however, inflation was better during World War II, averaging only 6% per year. But this was mainly due to price controls. When they were removed after the war, the price level jumped by a third between 1945 and 1948.

Want to see how insidious inflation is? Pull up some ads from the ‘30’s or ‘40’s and check the prices against todays. Then research the number of hours you needed to work to earn that amount.
Start here: Postage was 3 cents in 1940. Gasoline was in the ball park at 12 cents per gallon. A new car cost less than $1000.

Government loves inflation til it gets out of control and Zimbabwe’s the nation.

The question has an actual numerical answer. When the debt to GDP times the average interest rate the government can borrow at exceeds the long run nominal growth rate of the economy, you've hit the debt wall. At that point the interest on the outstanding debt is the growth increment to the entire economy. Anything shy of that is sustainable. Doesn't mean I am recommending it, I'm not. That is just where the wall is, mathematically and macroeconomically.

It is not something to worry about seriously with debt to GDP at 40% or even at 70%, when interest rates are at 3.5%, or even if they go back to a more normal 6%. It is something to worry about if you see interest rates more like 8% and debt to GDP nearing unity.

The last adult on any of this was Gingrich. It is not a time to doom monger it or pretend the wall is nearby when it isn't. But it is definitely not a time to be adding trillion dollar new entitlements or socking the economic with giant new tax increases.

The way it ought to be addressed is spending should halt in its tracks, recent emergency measures should not be repeated, and the economy should be given time to absorb policies already in place and to recover. Which it will, more than enough has already been done. Some of the special measures will reverse on their own (repayment of TARP e.g.), and the fall in tax revenue due to the recession will also abate. Do not spend more as this happens. Just let it take its course, and freeze spending, cutting discretionary stuff outright to make room for colas and such on the entitlement side.

Doing that would bring the budget back to rough balance in about five years. Beyond that, entitlement reform that slows the growth of give-aways to the middle class are what is needed, not giant new giveaways to buy another round of votes with borrowed money. Bush was irresponsible on drug benefits and Obama is twice as irresponsible with his current health care proposals. We need the opposite on both, gradual means testing and voluntary privatization ideas.

Gingrich laid all of it out correctly 10 years ago, and was called a mean spirited hater for his pains. But everything needed to solve it is clear. Just, nobody is willing to actually do any of it. They'd rather believe fairy tales and sling mud at each other.

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